Hitting the Debt Ceiling: An Anti-Stimulus at Least Twice as Large as the Stimulus in the Recovery Act

This blog post has been updated.

Several days ago Paul Krugman made a good point—while it’s really hard to be precise about how much it would hurt to slam into the constraint of the debt ceiling, we do know clearly that it would indeed hurt.

Say that Treasury decided to prioritize debt payments (and even say that interest on the debt doesn’t increase at all, which is unlikely), and cutback on other spending to levels that can be supported by incoming revenues rather than borrowing. This would by itself lead to a shock to GDP of well over 5 percent of GDP (annualized) when accounting for both the decline in spending (about 4 percent of GDP) and a modest multiplier.

To put this in some perspective, this negative shock is twice as large as the positive boost given the economy during the absolute peak year of the Recovery Act (ARRA’s addition to the deficit was just over 2.5 percent of GDP in 2010).

So, just the purely mechanical fiscal drag of being constrained by the debt ceiling would be equivalent to an anti-stimulus that was twice as large as the biggest stimulus package ever passed. And, of course, the non-mechanical impacts of hitting the debt ceiling that would result from chaos in financial markets make this a very conservative lower-bound estimate of what could happen.

Of course, nobody really thinks we’ll hit the debt ceiling and actually stop issuing new debt for an entire year. Each month that the debt ceiling is constraining spending would, in the scenario above, constitute a more modest drag of about 0.5 percent of (annualized!) GDP.

One would like to think that policymakers would never do anything so obviously stupid for the economy. But, we really already have—just at a slower pace. Since the official end of the Great Recession, we have enacted historically unprecedented degrees of austerity that have strangled recovery.

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